Crowdfunding is a way for businesses to raise funds without the need for bank loans or private equity firms.
The idea extends to fundraising for charities and individuals through online platforms.
Some big brands have launched crowdfunding campaigns, such as brewer Brewdog, Oculus – now part of Facebook’s Meta – and challenger bank Monzo.
The principle is simple. Companies invite large numbers of investors to pledge small amounts in exchange for shares, perks, or even a heartfelt thank you.
Crowdfunding is a great way for businesses to let people know they need money for a project.
Investors can choose from three types of crowdfunding:
- Equity Crowdfunding – If you fancy spinning in one of the chairs on BBC TV’s Dragons’ Den, take a look at crowdfunding by exchanging your money for shares in the company. How it works depends on the deal, so be sure to read the prospectus and spot the company.
- Crowdfunding based on loans – You can lend money directly to businesses through online peer-2-peer platforms. The rates of return are generally much better than those offered by any bank, and the platform verifies the financial situation of the borrower for you.
- Rewards crowdfunding – This option is for charitable investors and may appeal to vanity. Instead of shares or loan repayments, investors get recognition or rewards for investing their money in a project. For example, authors may offer a signed first edition of their book or give you a mention among the signings.
While rewards crowdfunding is just for that warm feeling of helping someone give, the other two choices offer some serious returns. Remember that you may have to kiss a lot of frogs before you find your princess – or her unicorn.
To crowdfund a business investment, go to an online platform like Sowers Where indiegogo for participations. Funding Circle and CrowdSpace are starting points for P2P lending, while Just give Where GoFundme publicize donation projects.
SEIS is the UK’s Seed Enterprise Investment Scheme. SEIS is one of the best tax incentives for business angels anywhere in the world.
Crowdfunding companies can apply for SEIS pre-approval from HM Revenue & Customs to join SEIS.
SEIS offers investors:
- 50% reduction in income tax on investments up to £100,000 meaning anyone investing £100,000 in a SEIS project can expect an income tax refund of up to £50,000
- No capital gains tax on rising stock prices
- Relief from losses if the company goes bankrupt
SEIS comes with other benefits, such as inheritance tax relief once the shares have been held for two years. Similar tax benefits are available to investors with more than £100,000 to invest in a project through the Enterprise Investment Scheme (EIS).
Financial risk goes with the territory in crowdfunding. Companies are often start-ups with no business history but with a lot of optimism.
Crowdfunding is not regulated in the same way as saving with a bank or investing through a financier, so you could lose all your money if the business fails to take off.
The UK’s Financial Conduct Authority regulates crowdfunding and requires platforms to keep investors’ cash in segregated client accounts to minimize losses.
Other issues include a limited market for trading crowdfunded stocks as they are usually with unlisted companies and not on stock exchanges.
Don’t just verify companies on one platform – in the past some platforms have also gone bust holding cash from investors, so include those in your due diligence.
Over 250 crowdfunding sites are active in the UK. Many platforms offer niche investments – Seedrs focuses on start-ups, while Starter houses artistic projects.
Here is how to invest in crowdfunding step by step:
- Specify the type of investment you wish to make.
- Decide which business or project you want to support with your money and check if you can take advantage of SEIS or EIS tax relief.
- You can never do enough due diligence, so ask for all the information the project has to offer, then scour the internet for reviews and data on similar businesses. Clarify the deadlines, the amount you are expected to provide, and the terms and conditions of the agreement. Remember that you need to hold SEIS and EIS shares for 36 months to get the best tax benefits.
- Take independent investment advice and potential benefits and pitfalls.
- Make your investment pledge on the crowdfunding platform by promoting the opportunity and wait to see if other investors will participate to reach the funding goal.
- Once the funding goal is reached, the money is transferred to the crowdfunding company and the project begins. If the amount collected does not reach the goal, the project stops and the money is returned to the donors.
Another investment option is through specialized funds.
Rather than direct crowdfunding, investors can choose to back a fund with shares in several diverse projects.
The advantage of investing through a fund is that someone else does the due diligence, investment risk is reduced as crowdfunding can take place directly or across multiple platforms. The downside is that fund managers and administrators will charge a fee to pay for their services.
While crowdfunding is a recognized and trusted way to raise funds for businesses, here are some of the statistics that underpin this opportunity as a profitable investment:
Equity crowdfunding raised over £332m from 433 projects in 2020.
P2P business lending hit £1.2bn – a significant 35% drop from funding levels in 2019 – the drop is mainly blamed on the coronavirus pandemic
Crowdfunding is a forum for businesses with little or no business history that would otherwise have difficulty raising funds from more traditional channels, such as banks.
A crowdfunding platform allows a company to pitch directly to potential investors who might not be reached through normal investment channels.
Equity crowdfunding is often the preferred option because the company does not have a return of capital or interest against equity.
Yes. The list is quite long, but Brewdog, the craft beer maker, has raised over £145m through crowdfunding in the UK. Monzo, the online bank, raised £20m before being bought out for £85m, while fitness company Peloton started as a crowdfunding business in 2013.
There is no maximum or minimum crowdfunding investment, although platforms and projects set limits. However, if the project has SEIS pre-approval, the total investment for each financial year is £100,000.
Risks are high because companies seeking funding have no business history. As a result, investors can lose all their money.
Dealing with a platform is simple – if you sign up and pledge money to a project, your money is reserved until the project reaches its goal and the money goes to fundraising. If the project does not reach the goal, the platform returns the money to the investors.
Most platforms publish detailed advice, but the most useful independent advice comes from an investment-specialized IFA with extensive experience in crowdfunding and P2P lending.
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